When is government spending expansionary?
It depends, argue Ascari et al. They look at how output responded to fiscal spending announcements during two separate periods in the US, namely the Great Inflation (1960q1-1979q2) and the Great Moderation (1984q1-2007q2) and find that output increased in the Great Inflation period while it decreases in the Great Moderation period. They argue that the effects of anticipated government spending shocks depend crucially on the prevailing monetary/fiscal policy mix.
They use a simple New Keynesian model which shows that both an unanticipated and a previously anticipated government spending shock increase output in both the monetary-led (M) and fiscal-led (F) regimes at implementation. But, fiscal foresight leads government spending shocks to have very different effects in the two regimes during the anticipation period:
In regime M, an anticipated fiscally backed increase in government expenditure is contractionary, i.e., it decreases output and consumption. In regime F, under unbacked fiscal expansions, in contrast, the same shock is expansionary, as it increases private consumption through the expectation of positive wealth effects.
Fiscal foresight and the effects of government spending: It’s all in the monetary-fiscal mix
Authors: Guido Ascari, Peder Beck-Friis, Anna Florio, Alessandro Gobbi
From: University of Oxford, PIMCO, Politecnico di Milano, University of Milan
When regime switch is endogenous
In this paper, Chang et al. jointly estimate the regime-switching monetary and fiscal policy rules in a bivariate system, and infer the interactions of monetary and fiscal policies. In particular, they assume a Taylor-type monetary policy rule in which the nominal interest rate depends on lagged interest rate, inflation, output gap and monetary policy disturbance; and a fiscal policy rule that adjusts tax revenues in response to government purchases, real market value of outstanding government debt, output gap and fiscal policy disturbance with policy smoothing. Their model has two unique characteristics that render the regime switch endogenous:
- First, they assume the vector of latent policy factors to evolve as a stationary vector autoregressive process to allow monetary and fiscal policy factors to interact dynamically and contemporaneously. The autoregressive coefficient matrix characterizes the dynamic policy interaction between the policy factors;
- Second, policy factors are allowed to receive feedback from past policy disturbances which may represent policy makers’ considerations beyond what is already reflected in target variables, it is this correlation that produces the dynamic feedback effects. The dynamic feedback establishes a channel through which additional information on the economy relevant for policy regime changes is carried over to the policy factors.
We find that the current monetary policy disturbance has sizable effects on the switching of next period monetary policy regime through self-feedback, as well as on the change in the next period fiscal policy regime through cross-feedback. On the other hand, a fiscal policy disturbance yields much weaker feedback effects on both monetary and fiscal regimes. Moreover, we report strong dynamic interaction between monetary and fiscal policies. Our measure of dynamic interaction between policy factors suggests that a change in fiscal policy regime leads to switching in the monetary policy regime.[…] We also find substantial evidence that the U.S. monetary and fiscal authorities have been interacting: central bank responds less aggressively to inflation when fiscal authority puts less attention on debt stabilization, and vice versa.
U.S. Monetary and Fiscal Policy Regime Changes and Their Interactions
Authors: Yoosoon Chang, Boreum Kwak, Shi Qiu
From: Indiana University, Martin-Luther University Halle-Wittenberg, Fudan University
